THE FINANCIAL PAGE GET SHORTY A few years ago, the Finance Min- istry of Malaysia suggested that a certain group of troublemakers needed to be punished. Caning, the Ministry said, would be the right penalt)r. And who were the malefactors being threat- ened with the rap of rattan? They weren't drug dealers or corrupt executives or even gum chewers. They were short sellers Short sellers are investors who sell as- sets (a company's shares, say) that they have borrowed, in the hope that the price will fall; if it does, they can buy the shares at a lower price, return them to the trader they borrowed them :&om, and pocket the difference. In effect, they are betting against a company's stock price. As a re- sult, they have, historicall been regarded with great suspicion, and though the Ma- laysian proposal was novel, the hostility behind it was not. Shorts have been reviled since at least the seventeenth century N a- poleon deemed the short seller "an enemy of the state." England outlawed shorting for much of the eighteenth and nine- teenth centuries. Just last year, Germany's Finance Minister suggested that short sell- ing should be banned during crises. Across the world, short sellers continue to be seen as conniving sharpies, spreading false rumors and victimizing innocent com- panies with what House Speaker J. Den- nis Hastert once called "blatant thuggerJ" The United States, it's true, hasn't re- sorted to the rattan, but it still enforces a set of rules against short selling that have been in place since the thirties, when shorts were seen as a cause of the Great Crash. In a country as optimistic and can-do as ours, there seems to be some- thing un-American about betting against stocks. That may be changing. The Se- curities and Exchange Commission is now proposing an eighteen-month ex- periment in which the most onerous re- strictions on short selling wotÙd be lifted for three hundred big stocks. If the mar- ket for these stocks worked well, the old rules could eventually be lifted across the board. And it's about time. "It's easy to make short sellers wear the black hats," James Chanos, the head of Kynikos Associates and one of the few pure short sellers around, says. "Short selling is always an emotional issue. Ex- ecutives have their egos tied to the price of their shares, so when you take a posi- tion against them they take it person- all " But give the short sellers their due: they're the canaries in the coal mine, rec- ognizing problems before others do. In the past few years alone, shorts sounded early alarms about blow-ups like Enron, Tyco, and Boston Chicken; they also un- covered scams at lots of smaller compa- nies that tried to cash in on the stock- market hysteria of the late nineties. In general, the companies that short sellers target deserve it. The economist Owen Lamont studied a group of companies that had clashed with short sellers-de- " , , ."J)J c .' r ) 1\.0' ".... ," stock markets around the world, they found that markets with active short sellers reacted to information more quickly and set prices more accuratel A traditional justification for short-selling regulations- including the rule the S.E. C. wants to re- peal, which prevents short selling when prices are already falling-is that they protect markets :&om panics. Yet the study found no evidence of it. There's a case to be made that in the late nineties restric- tions on short selling helped inflate the Internet bubble, by reducing any coun- terweight to the prevailing mania. This, in turn, worsened the eventual crash. If the S.E. C. does run its experiment, corporations are hardly going to drown in a deluge of short sales. Toda only two per cent of all United States stock- market shares are shorted, and even with looser restrictions short selling is likely to remain uncommon. In part, that's be- cause shorting stocks is simply arder than buying stocks: loans can be called in at any moment, and your potential losses are unlimited. More important, shorting demands a willingness to challenge Wall Street's foundational dogma: that stocks should, and will, go up. "I used to think that it should be as easy to go short as it is to go long," Chanos, who was one of the first to see through Enron's hype, says. ' ter all, the two things seem to require the same skill set: you're evaluating whether a company's stock price reflects its fundamental value. But now I think that they aren't the same at all. Very few human beings perform well in an environment of negative rein- forcement, and if you're a short, negative reinforcement is what you get all the time. When we come in every da we know that Wall Street and the news and ten thousand public-relations departments are going to be telling us that we're idiots. You don't have that steady drumbeat of support behind you that you have if you're buying stocks. You have a steady drum- beat on your head." By lifting the regula- tory sanctions on short selling, the S.E. C. might help to weaken the social sanc- tions. The result should be a better func- tioning market, which is in the interest of investors as a whole. Let corporations de- nounce short sellers all they want. The case against these bears is a lot of bull. -James Surowiecki z z <( w Z :r: a.. o l- V) ë2 :r: u .r nouncing them in conference calls with investors, imploring shareholders not to lend them stock, and so forth. He found that the average stock-market return for these companies over the next three years was minus forty-two per cent, which suggests that their stock prices were as in- flated as the shorts had claimed. Even when short sellers aren't uncov- ering ma1feasance, their presence in the market is usefiù. If you think of a stock price as a weighted average of the expec- tations of investors, restrictions on short selling skew that average by shutting out people with contrary opinions. It's a bit like setting a point spread for a football game by allowing people to bet only on one side. When a team of Yale manage- ment professors did a study of forty-seven 42 THE NEW YORKER., DECEMBER I, 2003